June 3, 2017 | Is there “Irrational Exuberance” in the U.S. Housing Market?

Robert Campbell

Robert Campbell is a real estate analyst and economist. He's been publishing The Campbell Real Estate Timing Letter since 2002. His book (Timing the Real Estate Market) presents a clearly defined method for predicting the peaks and valleys of real estate cycles.

(Excepts from my May 2017 Timing Letter and the speech

I gave at the FIBI real estate club in Pasadena, CA on May 18, 2017)

Survey after survey has shown that investors are most

bullish near housing market peaks … and most bearish near the bottoms.

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Why is that?

It’s because people tend to believe that what has happened in the recent past will continue into the future — and this “recency” bias is one of the biggest mistakes that investors make.

Buy Now or be Priced Out Forever?

When we were nearing the end of 2002-2006 housing bubble, “Buy now or be priced out forever” was the battle-cry of many individuals (and real estate businesses) who projected never-ending home appreciation.

At today’s highly elevated housing prices, could it be that that home buyers are now getting caught up in the same sense of irrational exuberance as they did near the end of the last housing bubble?

If we look to history for possible clues, Gallop has polled U.S. adults every May since 2005 about what they expect home prices to do in the next year.

A historical chart of Gallup’s poll findings is shown below – and in 2017, Gallop found that 61% expect housing prices in their local area will rise during the next 12 months. By comparison, this was the highest % since 2005 (70%) and 2006 (62%), which was just before the start of the U.S. real estate crash.

Equally interesting, Gallop found that only 10% of those polled in 2017 think that real estate prices will decrease in the next year. This is the lowest % since 2005 when only 5% thought prices would fall.

Sir John Templeton (1912-2008) once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Templeton, who became a billionaire as a successful investor, became known for “avoiding the herd” and “buying when there’s blood in the streets.” He also was known for taking profits when assets prices and expectations were high.

Although home prices are already high, my key timing indicators continue to say that 18 out of the 19 housing markets I follow are still likely to go higher from here.

The Los Angeles Housing Market

“If you want to be a superior real estate investor,” I told the audience, “you have to incorporate timing into your strategies.”

To show how cyclical Los Angeles housing prices are – and how there are clearly better times to be a buyer or a seller – I showed them the chart below. While my key indicators say the trend is still up, the chart also shows that nothing can save you from losses if you persistently buy at or near the top of the L.A. housing market.

In case you are new to my market timing work, please know that identifying major turns in housing markets is not crystal ball stuff. I instead use five forward-looking indicators that help you objectively grasp what is internally going on in the marketplace. They don’t tell you why but they do tell you what is happening – and “what” is all that matters.

As you can see – and it makes no difference whether you invest for long-term cash-flow or for shorter-term price appreciation – the entryprice is the first crucial factor in determining whether your futureinvestment returns are going to be excellent … or mediocre to poor.

That’s why I’ve always stressed to my students: learn how to time real estate markets. If you want to make bigger profits with less risk, it is the one skill that will make the biggest difference.

I know everyone hates to see real estate prices zoom upward without them, but at this late stage of the cycle, there is no rule that says you have to be “in the market” all the time – so prudent investors (and home buyers) should tread carefully from this point on.

Cash is an asset that gives you the ability to buy something at a lower price later on.

Because most U.S. housing markets are highly priced right now, there’s nothing wrong with hanging out in cash and waiting for the next low risk buying opportunity – and this is an especially good idea if you live in San Francisco Bay Area, which I will discuss next.

[BTW, If you insist on keeping your money invested in real estate – as opposed to cash – consider this REIT investment strategy]

The San Francisco Housing Market – Revisited

After housing prices in San Francisco doubled from 2012 to 2016, and when housing affordability hit 11% soon thereafter, I told my subscribers that prices had reached bubble levels – and that a sharp downturn in prices was coming. I also did a blog post here.

While my indicators have not yet signalled the start of a downturn, home price data from the Federal Home Finance Agency (FHFA) shows that housing prices in San Francisco fell 2.5% in Q1 2017 as compared with Q1 2016.

As shown in the chart below, this was the first decline in S.F. since 2011.

But the FHFA index only tracks home purchases financed with Freddie Mac and Fannie Mae conforming loans – which for the San Francisco Bay area are capped at $636,150. With the median S.F home price above $1.3 million (Source: California Association of Realtors), this therefore means the FHFA index may be leaving out a large number of home purchases in the area.

CoreLogic, however, tracks home sales in S.F. across all price ranges – and does not limit itself to conforming mortgage loans. Based on April 2017 data, CoreLogic Inc. reported that S.F. housing prices also fell on a year-over-year basis — down 4.0% from April 2016. for all home sales in San Francisco County was $1.3 million, down 4 percent from a year earlier. The number of transactions fell 12 percent, according to the data provider, which doesn’t limit its research to homes bought with conforming loans.

History tells us that California real estate markets don’t die of old age, they die because they become over-priced. In addition knowing which indicators to follow, there is a human side to being a great investor — which includes knowing when to part company with the herd.

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Coming in my July 2017 Timing Letter: How far are home prices likely to fall during the

next housing downturn? This is not just a wild guess, but if the historical pattern for the last 50 years continue to repeat, the decline could be more severe than 2006-2012.